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Australia remains a key target for cross border investment

Sydney, 23 July 2014 –Global investors are seeking to increase their investment in commercial real estate this year, with the Australian market remaining a key target for cross border acquisitions.

That was one of the key messages from today’s annual CBRE Sydney Market Outlook breakfast, which was attended by more than 400 property professionals.

CBRE’s Head of Research for Asia Pacific, Dr Henry Chin, told the audience that CBRE’s recent survey of 600 global investors had highlighted an increasing appetite for real estate investment in 2014 and had also revealed that buyers were showing a growing willingness to move up the risk curve to look at the value add and opportunistic space.

Key outtakes for Australia were the fact that Sydney was the No 1 city on the list for global investors targeting the APAC region, with Melbourne coming in at fourth position. On a country basis, China received top billing with Australia ranked No 2 – aided by the fact that this market still offered one of the highest yields across the major global markets

The survey also highlighted the very different concerns for investors by region, with investors in EMEA most concerned about the perception that prime real estate in gateway cities had become expensive; US investors focused on the prospect of rising interest rates and APAC investors looking at the potential for a slow-down in China and what impact that might have on economic conditions in the region.

Dr Chin’s forecast is that US will be the first to increase interest rates, with the expectation being that rates would rise by the second half of next year - potentially sooner depending on economic recovery conditions - and would stabilise at 4-4.5%.

Other influencers for the market that were noted by Dr Chin included the rise in Asian outbound investment and the potential for an influx of investment from Asian insurance funds.

CBRE data shows that Asian institutions invested US$25 billion in commercial real estate in the US, EMEA and Australia in 2013 – a rise of 142% from 2012. Some 15% of that investment was in Australian property – a significant percentage given the size of this market.

The next frontier will be Asian insurance companies, given the deregulation occurring in major markets throughout the region. Dr Chin said CBRE expected Asian insurers to invest US$75 billion in global real estate in the next five years.

Looking at Australia in more detail, CBRE’s Head of Research for Australia, Stephen McNabb said the market was expected to benefit from a gradual improvement in underlying economic growth.

For the retail sector, Mr McNabb said a positive sign had been the acceleration in sales in non-discretionary areas, for instance clothing and footwear, where sales growth had grown for 1% in 2013 to 6% this year.

“While sales growth is expected to ease back to underlying income growth levels, most categories are growing at a faster rate than the 2008-2013 average,” Mr McNabb said.

The market has also benefited from the continuing interest from foreign retailers, which has helped to keep vacancy rates low in major centres. Mr McNabb said these groups were attracted by the fact that Australia’s rate of consumption per capita was the highest in the world.

In terms of investment, CBRE’s forecast was that the more cyclical sectors would provide the best areas of investment opportunity, with large format retail centres expected to be one area to watch as sales growth improved and the high supply levels evidenced since the GFC began to stabilise.

In regard to the office sector, Mr McNabb said demand drivers were improving, however new supply would see Sydney’s vacancy rate increase by 2-3% to peak at 11-12% in 2015, which will hold back rental growth and see the rate of yield compression slow.

A positive for the Sydney market will be residential conversions, without which the vacancy rate could have peaked up to 3% higher. This had also ensured that the Sydney market was more balanced than other markets nationally, with the exception of Melbourne.

On the industrial front, Mr McNabb said it was a “tale of two sectors’ – those being manufacturing, where output was flat, and transport/storage which was a defensive sector aligned with consumer spending.

However, demand and supply looked balanced in the short term and rental growth was expected to improve, which would support yield compression in the industrial sector.

A panel discussion concluded the breakfast, with some of the key takeaways being as follows:

For the Sydney market, Mr Haddon said long awaited infrastructure investment, including the planned second airport at Badgery’s Creek were a positive for the market and would be a draw for occupiers and investors.

“The recent Badgery’s Creek announcement will create the next "Eastern Creek" in terms of logistics development and investment opportunities in NSW. Occupiers will lag speculators however, as logistics operators will only move once the infrastructure is in place. Therefore, we expect to see considerable maneuvering as Industrial market players seek to take land positions that will change the face of the market in the medium to long term,” Mr Haddon said.

In relation to the investment market, Mr Haddon said the current high buyer demand had driven yields for super prime assets below 7%. However, he stressed that the market dynamics were very different to pre the GFC when the yield differential between prime and secondary assets was 50-100 basis points versus the differential in today’s market of 200-300 basis points. Purchasers had also become more discerning and DD was no longer an acronym for “done deal”, Mr Haddon said, with buyers more willing to walk away from transactions. Offshore purchasers were now also including industrial assets in their buying mandates and this had added to the depth of the buyer pool and created a level of competition not seen in pre-GFC markets.

The heavy competition for prime industrial assets was also influencing purchasers to explore non-traditional asset classes, such as Refrigerated Logistics. “A number of offshore groups in the food industry have identified Australia as the “protein fountain” of Asia Pacific and are looking to invest in infrastructure that supports that industry,” Mr Haddon told the audience.

Office leasing: Andrew Tracey – Regional Director, Office Services

A significant shift for the Sydney market has been improvement in enquiry levels compared to 2013. However, Mr Tracey noted that the most important change had been the improvement in lease conversion rates, with more tenants making long term commitments and moving to accommodate future growth.

“Some 50% of the people we’re talking to are talking about moving for growth which is a really positive sign of green roots in the market " Mr Tracey said.

He noted that the Sydney market remained very competitive, with 271 current options for tenants seeking whole floors. In this environment, Mr Tracey said how landlords positioned their assets was fundamental and differentiation of product was essential. “There is also an imperative to deliver product that met the needs of the next generation tenants such as tech companies of the ilk of Dropbox , Salesforce, LinkedIn and the like who are in businesses we hadn't thought of a decade ago,” Mr Tracey said.

In relation to incentives, Mr Tracey said the market had peaked, however rents were expected to remain stable in the next 12 months.

“Differentiation and a customer centric focus will be the most important thing over the next 12-18 months.”

Mr Hynes agreed that incentives had peaked but said there was no sign of any quick reduction in incentive levels. One trend he did note was that tenants were looking much further out to renegotiate their leases and were in some cases signing new leases three to five years ahead of the expiry date. Mr Hynes said this was effectively being funded by landlords picking up lease legacies and was bringing forward tenant demand.

“For the overwhelming majority of tenants we’re talking to the key factors they’re still focusing on are cost saving and space savings through more efficient use of space, workplace models such as ABW and in some cases through reducing headcount,” Mr Hynes said.

He noted that tenants were capitalising on the current market conditions to upgrade their space, but some were also considering options such as offshore or splitting their workforce to move a portion of staff to secondary space.

Office investment: Josh Cullen – Regional Director, Capital Markets

Mr Cullen noted that yield compression was still occurring in the major office markets, with recent campaigns such as CP3, 1 Charles Street in Parramatta and 52 Martin Place in the Sydney CBD having all achieved benchmark results for their respective market sectors.

In the case of 52 Martin Place, Mr Cullen said the campaign had attracted six or seven groups who were new to the Australian market – highlighting the continued attractiveness of this market to offshore investors, particularly for prime assets. However, with a lack of core opportunities, Mr Cullen said both offshore and onshore investors were expected to increasingly move up the risk and look at more value-add opportunities.

“Core will continue to outperform but we will start to see a growing number of buyers look to take on risk for reward,” Mr Cullen said.

He noted that the Sydney office market continued to be the number 1 target for offshore groups, however he noted that Brisbane had been the second most active investment market in recent times, despite the city’s weaker underlying fundamentals. Melbourne had been relatively inactive but this was due to a lack of stock and Mr Cullen said a number of current and upcoming campaigns were expected to provide an entrée for new investment.

Residential: David Milton – Managing Director, Residential Projects

Mr Milton noted the continued strength in the Sydney residential market, with CBRE’s Residential Projects team receiving 1800 buyer enquires a week versus 1500 enquiries at the same time last year.

This was translating into higher sales rates, with 1600 apartments sold in the first half of 2014 versus 1400 apartments for the corresponding period in 2013.He also noted that pricing had increased significantly, with the team’s average sale price this year being $950,000 versus an average of $720,000 last year.

Mr Milton said the strength of the market was underpinning significant developer interest, particularly from offshore groups.

“Every week we have Chinese developers visiting Sydney wanting to secure sites valued at between $50 million and $100 million, which is just incredible,” Mr Milton said.

Retail: Neil Proudlove, Regional Director, Retail Investments

Mr Proudlove said the NSW retail investment market was currently in a “sweet spot” and was expected to remain so for the next 12 to 18 months. This was underpinned by strong underlying fundamentals, including; early 2014 sales growth of 5-6%, fewer retailer defaults and low vacancy rates through centres.

However, Mr Proudlove noted that room for rental growth on new lease deals was generally limited, given occupancy costs remained relatively high and retailers were operating on low margins.

His tip for passive buyers is to chase covenants, good Weighted Average Lease Expiries and to utilise current cheap debt in securing new investments. For active investors, Mr Proudlove said there were an increasing number of opportunities for this style of investor as some larger institutions shed non-core, generally smaller, retail assets.

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